There is a new piece of legislation pending in Congress which can substantially change relief currently available to employers who may have misclassified workers as independent contractors. James McDermott, a Washington State Congressman, has introduced legislation that would make it more difficult for employers to receive protection from a potentially large employment tax assessment resulting from worker misclassification. The legislation, which is called the “Taxpayer Responsibility, Accountability, and Consistency Act of 2008,” would also increase information reporting penalties
Current Requirements for Section 530 Relief
The legislation primarily focuses on Section 530 of the Revenue Act of 1978. Under Section 530, employers who misclassify workers as independent contractors rather than employees can find protection from potentially large employment tax assessments if they meet the following three requirements: (1) an employer has reasonable basis for treating workers as independent contractors, (2) an employer consistently treated the workers in question as independent contractors;, and (3) an employer have consistently reported workers as independent contractors to the IRS by filing all the appropriate tax forms and returns (i.e. Forms 1099). An employer can meet the “reasonable basis” requirement if judicial precedent, IRS rulings, a past IRS audit, or industry practice supports the classification of a worker as an independent contractor.
New Proposed Rules
The new legislation would repeal Section 530 and replace it with a new Code section, IRC §3511, that would make it more difficult for employers to avoid employment tax liability if they misclassified a worker as an independent contractor. IRC §3511 would generally require employers to have a “reasonable basis” for classifying a worker as an independent contractor, however, it appears that “reasonable basis” is construed more narrow than “reasonable basis” under Section 530. Under the proposed law, the “reasonable basis” standard is met only if:
(1) The employer classified the worker as an independent contractor based on: (i) a written determination that addresses the employment status of either the worker in question, or another individual holding a substantially similar position with the employer; or (ii) a concluded employment tax examination of the worker, or another individual holding a substantially similar position with the employer, that did not conclude that the worker should be treated as an employee; and
(2) The employer (or a predecessor) has not treated any other individual holding a substantially similar position as an employee for employment tax purposes for any period beginning after Dec. 31, 1977.
The new legislation would not allow an employer to rely on an examination commenced, or a written determination issued, if: (a) the controlling facts and circumstances that formed the basis of a determination of employment status have changed or were misrepresented by the taxpayer, or (b) the IRS subsequently issues contrary guidance related to the determination of employment status that has a bearing on the facts and circumstances that formed the basis of the determination of employment status. Furthermore, unlike the current law, a taxpayer would not be able to rely on industry standards or practices.
The new statute would apply to services rendered more than one year after the date that the legislation is enacted. Section 530 would not apply to services rendered more than one year after the date that the legislation is enacted.
Current Information Reporting Penalties
Under current law, a taxpayer that doesn’t file a correct information return may be subject to the following penalties:
- a $15 per return penalty if corrected within 30 days after the due date, up to a maximum total penalty of $75,000 a year ($25,000 for small businesses);
- a $30 per return penalty if corrected later than 30 days after the due date but before August 1, up to a maximum penalty of $150,000 a year ($50,000 for small businesses);
- a $50 per return penalty if not corrected by August 1 (or if a return is not filed at all), up to a maximum penalty of $250,000 a year ($100,000 for small businesses).
A “small business” is defined as a business entity whose average annual gross receipts for the three most recent tax years ending before the calendar year in which the returns are due (or for the entire period of its existence, if less than three years) are $5 million or less.
Increase in Penalties
Under the new law, a taxpayer that doesn’t file a correct information return would be subject to the following penalties:
- a $50 per return penalty if corrected within 30 days after the due date, up to a maximum total penalty of $500,000 a year ($175,000 for small businesses);
- a $100 per return penalty if corrected later than 30 days after the due date but before August 1, up to a maximum penalty of $1,500,000 a year ($500,000 for small businesses);
- a $250 per return penalty if not corrected by August 1 (or if a return is not filed at all), up to a maximum penalty of $3,000,000 a year ($1,000,000 for small businesses).
The new law would also increase the penalties for failure to furnish a correct payee statement, intentional disregard of the rules, and failure to comply with other information reporting requirements (see IRC §6723).
The legislation has been referred to the House Ways and Means Committee. Congressman McDermott introduced similar legislation in 2008.
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